Ontario's infrastructure boom comes to Toronto's west endAlyssa Bistonath
On a flying visit to Ottawa in January, Dalton McGuinty, Ontario's Liberal Premier, had the bearing of a man on a nation-building mission. And for good reason: The day before, he'd startled Ontario from the floor of the Toronto Stock Exchange with news of a $7-billion deal aiming to turn the province into North America's green-energy heartland. Today, speaking to an overflow crowd in the lobby of a brand-new cancer treatment centre, McGuinty happily stole a march on his prorogued federal counterparts. Amidst heartfelt cheering after opening the new facility, he sent a pointed message to his peers studying their budget options elsewhere in the national capital: "It's extraordinary what you can accomplish," the Premier deadpanned, "if you can stop worrying about who's going to take the credit."
But who could blame McGuinty, even if he did want to take some ownership of Canada's infrastructure boom? While Ottawa looks for ways to modestly stimulate spending, Ontario's Liberals are engrossed in perhaps the largest building spree in Canadian history. Undeterred by a $25-billion deficit, Ontario is well into a $90-billion, 15-year mega-scheme aimed at renewing the province's roads, jails, schools and, most urgently of all, hospitals. "We've got to keep the capital-spending dollars flowing," McGuinty pledged while showing off Ottawa's new cancer centre, which was paid for, he noted, with an $82.5-million grant.
That provincial grant-and the cancer centre it created-is best appraised in a wider frame than government leadership: Much of Ontario's building boom is the work of a powerful alliance of builders, bureaucrats and bankers that is quietly sliding an entirely new foundation across some of the Canadian economy's most important terrain. Thanks to this alliance, the money behind McGuinty's smile in Ottawa didn't actually come from his own pockets. It came from a consortium of private lenders in collaboration with a major construction company and a team of government deal makers. Working within the rubric of public-private partnerships-a concept that, when bruited a decade ago, was a red flag to public-interest watchdogs-the emergence of the builder-bureaucrat-banker triumvirate has fudged the lines between government and banking, and transformed the construction
industry along the way. As each new public-private project is unveiled, a set of increasingly competitive builders are making themselves into government partners-specialists in the lucrative niche of soothing politicians' headaches while freeing governments to roll-out politically juicy infrastructure coups without ever directly adding a dime to public debt.
And that debate over the propriety of mixing up the public interest and private profits? That's so 1990s. "There's no magic in it," McGuinty punched home after trumpeting the new public-finance realities manifest within Ontario's massive infrastructure drive. "You just want to do it in a way that doesn't saddle your kids with excessive payments."
THE BUILDERS
Through the ninth-floor window over Brad Nelson's shoulder, a bulldozer about the size of a Tonka toy inches down an embankment toward a miniature dump truck surrounded by tiny workers in hard hats. What looks like a sandbox scene could be part of a Bob the Builder episode but for the fact that Nelson, who is COO and president of Canadian buildings at PCL Constructors Inc., was filling the foreground in his Mississauga office with full-scale business talk of a sort rarely heard these days among upper-echelon Canadian executives. "Last year was our best year ever, for sure," Nelson said proudly. "And we expect we'll do just about the same this year."
Employee-owned PCL, Canada's largest construction company, doesn't disclose a great many numbers, but it currently signs about $6-billion worth of deals annually, Nelson estimated. Its biggest recent coups were the hospital-building jobs it won in 2009: a $759-million facility for the Niagara region and a $622-million project on the site of Toronto's Don Jail. "This is one of the first cycles where governments got it right and spent money when the private sector isn't," Nelson said. "It's a good healthy construction market."
PCL's competitors agree. At EllisDon Corp., Canada's second-largest construction company, senior vice-president John Bisanti describes business conditions as the best he's seen in 25 years. Like PCL, privately held EllisDon doesn't make many numbers public. But Bisanti estimates the Mississauga-based company completed more than $2 billion worth of projects in both 2008 and 2009. "In dollar volume, this is the hottest time I've ever seen," Bisanti said. "It's pretty exciting."
At Aecon Group Ltd., which is smaller than PCL and EllisDon but ranks as one of Canada's largest publicly listed builders, president Scott Balfour sees "a very, very robust market for hospitals, universities, and increasingly, transportation infrastructure." At $707 million, Toronto-based Aecon's third-quarter earnings last year were up almost 30% over the previous year's. The project pipeline was up 28% over 2008, hitting $1.9 billion. "We've been blessed," says Balfour.
While private-sector investment chokes up thanks to the recession, scores of Canadian construction companies-not just the giants but also small and medium-sized firms-are being buoyed by the infrastructure wave. The construction industry "will continue to outperform much of the Canadian economy through the recession period from 2009 to 2012," predicted the Construction Sector Council, an industry lobby group, in a recent report. The council estimated that 150,000 jobs will be created over the decade ahead.
A huge new wave of major contracts-many of them valued at well over $500 million-has yet to break. Leafing through a spreadsheet of forthcoming projects he tracks from his Mississauga office, EllisDon's Bisanti says that over the year ahead he expects to see 18 projects with a total value in excess of $3.5 billion tendered in Ontario, and a further $1.5-billion's worth in British Columbia, New Brunswick and Nova Scotia. "And that's just in the social sector-mostly for hospitals," he clarifies. "The best is yet to come."
According to Infrastructure Ontario, of 28 projects completed or underway-hospitals, prisons, courthouses, police stations and a massive provincial data centre-two-thirds are the work of EllisDon, PCL and Aecon.
Measure the dominance of these companies not by the number of contracts they've won but by the value of their contracts, and their hegemony seems even more impressive. Long experience with large, financially complex public projects has given PCL, EllisDon and Aecon huge competitive advantages, executives like PCL's Nelson confirm. "We've got almost 45% of the value of all the Infrastructure Ontario contracts," he claims. "That's a pretty good success rate."
Aecon's Balfour describes his two major competitors' control over the market for the hugely tantalizing public-private mega-contracts as "something of an oligopoly to begin with." Carving out a bigger piece of the pie for Aecon is a key strategic goal for Balfour: "There are only a limited number of contractors who have the ability to win these contracts. As the jobs get larger and larger, we're forced to partner with other experienced players."
Balfour points to a recent bid to design, build, finance and maintain Women's College Hospital in Toronto. Aecon is competing with one consortium led by EllisDon and another by Bondfield Construction, a mid-sized Toronto company that partnered for the bid with Bilfinger Berger, a German "multi-service group" rooted in the construction industry. To help it compete, Aecon teamed up with another European giant, the Spanish firm Acciona. In this market, it's go big or go home. "We're just now heading into a time when our capabilities can shine," says Balfour.
The new-school consortia can be highly complex. For its winning bid on the hospital in the Niagara region, PCL assembled a team spanning five nations that includes two teams of architects, six financial firms, two infrastructure investment firms backed by major banks and pension funds, and a company specializing in long-term facilities management. Although Nelson says the sheer scope of its bid required PCL to put upwards of $6 million into its proposal-an investment that companies, should they lose a bid, cannot recoup beyond a partial subsidy from the provincial government-he isn't complaining. "Without the impetus of a public-private partnership program, many of these projects would have languished for years," says Nelson.
Winning major public-private contracts requires "a total shift in thinking," says Bisanti at EllisDon. The strongest, most sophisticated players-those capable of making substantial equity investments while prying huge sums from lenders in a domestic market that is now attracting international heavyweight competitors like Bilfinger Berger and Acciona-are reaping enormous rewards, says Bisanti. "We're no longer just a bunch of bricklayers," he summarizes.
THE BUREAUCRATS
Many of the 10 women playing billiards at the Runnymede Healthcare Centre on a summer day last year suffer from debilitating syndromes like Huntington disease and Alzheimer's. But they seem to be enjoying each other's company, and the team of caretakers on hand is determined to keep them happy. Even so, Connie Dejak, CEO of the Toronto facility, is upset to see her wards spending a sunny day in a cramped basement room. "This building was erected as a school in 1908 and turned into a long-term facility in 1945," she says. "It's just not a suitable place for the care of these people."
The government of Ontario first acknowledged that the 100-bed facility should be replaced in 1987, says Dejak. But action was slow in coming. Even after a $6.5-million grant was issued in 2003 for a new building, "nothing happened. We were approved to tender a contract to build a new hospital and then nothing happened for three years. The system leaned on delays and inaction," she says with serious heat. "Until this guy appeared."
John McKendrick, the man at Dejak's elbow, is senior vice-president for project delivery at Infrastructure Ontario, the arm's-length agency charged with managing most of the large, privately financed contracts the provincial government is now busily tendering. For five years, he has criss-crossed the province, meeting with frustrated health-care managers like Dejak, trying to hammer out strategies to modernize and expand facilities. "As I went from hospital to hospital, I realized that we were going to have to take urgent steps," he says, recalling some especially sobering scenes in rural areas. "We had to start building."
At Runnymede, McKendrick's solution was simple enough: Under a process managed by Infrastructure Ontario on behalf of the hospital, an $89-million replacement that more than doubles capacity has now been built by Bondfield on the old facility's former parking lot. The old building was torn down in February.
Rather than tendering the contract and advancing Bondfield a large sum of money, McKendrick insisted on a contract that required Bondfield to find a private lender-which turned out to be the Ontario Teachers' Pension Plan-willing to finance the $63-million construction cost. Only when the job was completed did Infrastructure Ontario pay Bondfield. If Bondfield had been late in completing the job, it would have suffered interest costs on the debt held by Teachers', a cost that Bondfield's vice-president, John Aquino, estimated at $30,000 a day. "Forget it. That's not going to happen," Aquino declared while the project was still under way. "In fact, we're two months ahead of schedule, which is a very nice problem to have."
Having to go out and find $63 million added a layer of complexity to the Runnymede deal, says Aquino. But the requirement does act as a prophylactic against screw-ups and delays. "If you have the costs advanced as a float, there's a lot more leverage in charging for design changes that result in cost overruns, and there's really no benefit in finishing early," he explained, "whereas, if you finish early, there could be significant savings." In other words, when you pay the contractor in advance, you have far less leverage to get the job done right at the originally agreed price. At Runnymede, the job was completed two months early, says Aquino. Thus Bondfield saved itself $1.8 million in interest costs.
"The problem with the traditional contract is there's no one looking over the builder's shoulder," says McKendrick. "With a lender involved, you get all the issues that lead to delays and costoverruns on the table in advance. The lenders drive the due diligence. They monitor the project. At Runnymede, Teachers' had a consultant watching the whole process very closely," he says. After all, Infrastructure Ontario's list of potential construction risks-ranging from changes in government funding policies to labour troubles-runs to 30 pages. "I go to hospital after hospital where the administrations have hardly any idea of what the risks are. And there's nothing worse than renegotiating the contract once you've already paid 90% of the money," McKendrick says. "This way, we never have to deal with nightmares like that. We've unloaded most of the avoidable risks."
This is, after all, the key test in government projects: Is the public being taken for a sap? For governments, the advantage of the public-private partnership (or "P3") is that it imposes market discipline on builders prone to cost overruns and construction delays, while also keeping financing costs off the ledgers. The public is far less exposed to boondoggles like the Darlington nuclear plant, which infamously saddled taxpayers with somewhere in the order of $8 billion in overruns.
The P3 approach was pioneered in Canada by Montreal-based SNC-Lavalin, a company that has leveraged its Canadian base into the global infrastructure-building arena. From a standing start building hydro dams in Quebec, SNC-Lavalin now manages 10,000 projects with "huge presence in Chile, Brazil, France and India, just to mention a few places," says chief financial officer Gilles Laramée. A landmark Canadian job was Ontario's 407 toll highway.
The core concept of the P3 model is that governments do not pay up-front for new projects from tax revenues or by taking on debt. Instead, lenders such as banks, insurance companies and pension funds provide financing to builders in return for long-term payments for the facilities from governments.
Not only are governments abandoning their traditional role of advancing publicly raised funds to build new facilities, they are also unloading responsibility for maintaining them. Increasingly, within a contract model known as "Design, Build, Finance and Maintain," virtually all responsibility for operating large public infrastructure facilities is being contracted to private companies. The contracts for such deals-which do not involve professionals such as health care, educational or correctional personnel-are highly complex and are often designed with lifespans of 30 years or more.
THE BANKERS
From his perch on the 68th floor of Toronto's Scotiabank Tower, Bert Clark, 38, the bank's Canadian head for global infrastructure finance, can count five construction cranes swivelling around the skyline. "I just got back from Hawaii," he cracks. "Give me until the end of the week and we will have a few more up."
Clark spoke only partly in jest. Over the past two years he's completed enough infrastructure financing deals to put Scotiabank well ahead of its domestic competitors in a lucrative sector described as a key growth area for financial services companies. Clark's ability to do this stemmed in large part from his personal connections: His previous job was as a senior vice-president at Infrastructure Ontario, and before that he was an infrastructure adviser to Dalton McGuinty. In that post, he was tasked with helping to recraft infrastructure policy around a type of public-private partnership known as Alternative Financing and Procurement.
"The McGuinty government had campaigned against privatization of infrastructure," Clark recalls. "In office, they quickly realized they would need private-sector expertise and capital. Since then, they've used private finance to build new infrastructure as much as any government in the world. And Ontario and Canada are probably now the biggest infrastructure markets in the world."
Bay Street, Clark observed, is slowly awakening to this news. "The early pro-jects in Canada were primarily financed in Europe. The Canadian banks weren't interested." Many of these early projects were built by European construction companies that had morphed into infrastructure groups before the trend hit their Canadian counterparts, he added.
The insights Clark gained in government helped to give his Scotiabank team-10 people in Toronto and another 10 divided between the financial capitals of New York and London-a relatively easy lead, both in advising infrastructure groups on how to structure deals, and in actually raising financing. "We're on every project in Canada, working with strong bidders, and we're tracking 15 to 20 further medium-term projects worth approximately $6 billion in private debt placements," he summarized while pointing to Scotia's success in helping to secure a $293-million, 30-year deal to rebuild Toronto's Centre for Addiction and Mental Health, just before Christmas.
Within this deal, which was awarded to a consortium assembled around construction company Vanbots, Scotia and two other lenders underwrote an $86-million bond yielding just over 7% that matures in 2041. Scotia also arranged a two-and-a-half-year loan of $115.4 million, due in 2012, that will be repaid once Infrastructure Ontario issues a completion fee. The consortium partners invested $21 million of their own equity in the project. For all their work over 30 years-design, construction, project financing and building maintenance-the partners will be paid $293 million by the province.
For the lenders, "These investments pay well," says Clark. "You can invest in a hospital where you have 100% tenancy by the government for 30 years. It's an attractive investment. In the current climate, in fact, it's very attractive."
But beyond investing in publicly listed companies with a direct stake in P3s, Clark says that "there aren't a lot of opportunities for Canadian investors to participate in P3 programs, and that's unfortunate."
The downside for investors who are lucky enough to get in on these deals, admits Clark, is the risks banks face when they advance money. First, because 30-year loans have become hard to find, there is a risk that mid-term refinancing costs will balloon unexpectedly should interest rates suddenly spike upwards. Second, there is the risk that construction and maintenance partners could mess up and therefore fail to receive government payments. "The consequences of such failures have been transferred from governments to us," Clark acknowledges. "So we absolutely sweat the details. We're interested in these things coming in on time and on budget in a way that the government never was, and cannot be."
The opening of the William Osler Health Centre in Brampton, Ontario, in October, 2007, was the sort of event that a senior member of the Ontario government might have been expected to attend. At upwards of $600 million, the centre was a major public investment in one of the country's fastest-growing regions. But instead of sending someone to take credit, the provincial Liberals let the honour go to a key former adversary, Tony Clement, the then-minister of health for the federal Conservatives.
It was Clement, who, as minister of health for the Ontario Tories six years earlier, had initiated the Osler project as a then-unprecedented public-private hospital partnership to be built by EllisDon with financing from a consortium of Canadian banks. "Those who followed me in provincial politics will know that [the Liberals]stuck with the plan," Clement told the assembled crowd as he praised McGuinty's government for building the country's most advanced hospital using what he acknowledged was a "controversial" approach. "There has not been an apocalypse, last time I checked," he crowed. "You can have a public-private partnership with full public access. The debate is over. The results are in. And now Brampton can forge ahead."
Slightly over a year later, in an event that went a long way to explaining the Liberals' no-show at Osler's opening, a set of accounting results on the Osler project were released. In a scathing 22-page audit, Ontario's Auditor General revealed that had the government borrowed the money instead of handing that obligation to EllisDon and partners, the savings would be approximately $107 million in 2004 dollars over the term of the project's 25-year arrangement. There were many other problems large and small, the auditor found.
Among the bigger ones: The costs of building Osler through traditional procurement had been hugely exaggerated in order to justify a public-private deal. Among smaller worries: Nine legal advisers alone earned $12 million on the contract. And in almost every respect, the Osler audit bore out criticisms of the government's private-partnership program from the Ontario Health Coalition, an activist group that insists borrowing costs remain far too high and other costs inexplicably inflated within a program the government has consistently sheltered from accountability behind claims of commercial confidentiality.
Tellingly, although it remains the largest project yet completed by Infrastructure Ontario, Osler is not included in the list of projects on the agency's website. This is because the Osler project is considered an orphan, says David Livingston, the agency's president and CEO, since it was already in full swing when Infrastructure Ontario was created in 2005. "With Osler, they had to make it up as they went along. The model has evolved," he says. "We've done 28 more projects since then."
Thanks to the standardization of contracts, costs have gone way down, Livingston says. But some Osler-type escalations cannot be avoided, it seems. One is the additional need for lawyers. "Legal fees can be shockingly high," says PCL's Nelson. Another is the cost of financing: By relinquishing preferential borrowing rates available only to governments, privately financed infrastructure projects pay more for money. That alone pushes up overall project costs as much as 10%, confirms Livingston. In his view, however, that's a cost increase the government is prudent to accept. "Within privately financed projects, construction companies have far greater incentive to get projects built on time and on budget," he argues.
That's the ultimate argument for P3-it's so powerful, in fact, that it might explain why the tremors of debate over P3 subsided without notice. Among policy-makers, the focus is now on creating sufficient competition in the infrastructure sector. Looking back on the Osler debacle, Livingston argues that Ontario is far better protected now due to the emergence of a league of new competitors.
Which is no accident. His biggest challenge, says John McKendrick, Livingston's deputy, is getting builders to "grow up" and accept risks previously held by their government clients. Infrastructure Ontario is playing a mentoring role to Bondfield, encouraging what was a modestly ambitious company, dependent on traditional client-funded contracts, to plunge into the pool with bigger competitors. "To achieve maximum competitive efficiency, we have to go out and recruit companies like Bondfield," McKendrick says.
Bondfield says they're keen to compete. "I'd love these guys to keep the contracts smaller," vice-president Aquino says, referring to Infrastructure Ontario. "But the larger projects are geared toward larger companies. And that's what we want to be."
The bigger prizes Aquino is now savouring include competitions Bondfield won to build hospitals planned for Windsor and the Credit Valley region, west of Toronto. For the Runnymede deal, he says with pride, Bondfield was the first Ontario infrastructure bidder to get backing from a pension fund. On the Credit Valley job, Bondfield's partnership with the giant French bank Société Générale showed further creativity and international wherewithal.
For Livingston, driving competition has become a key mission. EllisDon, for instance, has been "forced to raise their game," he says with evident satisfaction. In a couple of recent instances, EllisDon and PCL didn't make it to the short-list for major infrastructure projects, Livingston notes. For taxpayers hoping to see more public facilities built with less leakage into private pockets, that could be a sign of very good things to come, he argues. "More competitive tension is exactly what we need." Who could disagree?
PUBLIC-PRIVATE PARTNERSHIPS: A TALE OF TWO PROJECTS
THE BAD: The 407 toll highway Getting across the Greater Toronto Area by car is a grind. But if you're prepared to pay, you can zip along the 407 ETR, a 108-kilometre toll road built by a consortium that included SNC-Lavalin. The early 1990s project, costing roughly $1.6 billion, was one of Canada's first major experiments in public-private partnerships-except that, as the provincial auditor noted in 1996, the province took on such a disproportionate share of risk that "a public-private partnership was not established." In 1999, Ontario leased the 407 for 99 years to another consortium, again including SNC-Lavalin. Queen's Park pocketed $3.1 billion, which meant it could boast of doubling its investment. But was the world's largest road privatization really such a great deal? About 400,000 trips are taken on the 407 daily, producing more than $400 million a year in tolls. Maintaining the road costs about a $100 million a year, and the consortium has invested more than $1 billion in improvements since 1999. But even so, the driving public is continuing to pay dearly for something that has effectively already been paid for. While campaigning for office, Premier-to-be Dalton McGuinty promised to undo the privatization-"on behalf of Ontario consumers"-but has failed to do so.
THE GOOD: Roy McMurtry Youth Centre When this sprawling 192-bed centre in Brampton, built for youth in legal trouble, officially opened last summer, the presiding cabinet minister offered "a big shout-out for Infrastructure Ontario, who, my aide just whispered in my ear, saved us millions of dollars." Infrastructure Ontario is the agency that had the centre built at a cost of $93 million, which was provided through loans to a construction company from private lenders. That actually meant that the financing costs were higher than they would have been had the government borrowed the money at its own preferential rate. And because the builder agreed to accept all risks of cost overruns and delays, the province paid about $7 million more than it might have in a traditional contract. But according to an audit of unverified figures provided by the government to PriceWaterhouseCoopers, Ontario taxpayers actually saved about $9.4 million using this approach. How so? Escaping the risk of cost overruns and construction delays was valued at $18.2 million. By paying its private partners more to accept risks that have often inflicted big costs on the public in the past, Ontario arguably came out ahead.